Category: 2019

There’s a new big cheese at Papa John’s — and embattled founder John Schnatter is not happy about it.

The pizza franchisor announced a $200 million investment from hedge fund Starboard Value Monday in a deal that places the fund’s boss Jeff Smith in the chairman seat.

The deal between Papa John’s and Smith’s Starboard Value also threatens to further loosen Schnatter’s influence over the company he founded in 1984, by expanding the board and diluting his stock.

It weakens Schnatter’s voice on the board by adding three new directors, including Smith and Anthony Sanfilippo, former chairman and CEO of casino operator Pinnacle Entertainment.

The company also added a seat for Schnatter’s nemesis Steve Ritchie — who became CEO in December 2017 after Schnatter was booted over his criticisms of the NFL’s handling of football players kneeling during the national anthem.

In addition to expanding the board, the $200 million investment gives Starboard a new chunk of convertible preferred stock that stands to shrink Schnatter’s stake from 31.1 percent to about 26 percent, according to restaurant analyst Mark Kalinowski of Kalinowski Equity Research.

“It doesn’t neutralize him, but his percentage of voice on the board goes down,” said John Gordon of Pacific Management Consulting Group.

A source following the situation said the deal suggests Papa John’s may be seeking to start a sales process that could have a better chance of success with Schnatter owning a smaller stake.

Private equity firms circling the company during its recent woes were hesitant about bidding for the pizza-maker with Schnatter owning 31 percent, this person said.

The pizza slinger is evaluating his “legal remedies” over Papa John’s decision to choose Starboard’s offer over his own, according to a filing with the Securities and Exchange Commission.

Schnatter’s SEC filing describes his $250 million counteroffer as “essentially the same” as Starboard’s but at a lesser cost to the restaurant company.

Schnatter could buy more stock to boost his stake, but he faces a “poison pill” that was implemented last year to prevent him from amassing too many shares. The poison pill is set to expire in July.

Shareholders cheered the investment Monday, sending the stock up almost 9 percent, to close at $41.97.

Smith pulled off a coup at Darden Restaurants in 2014 by replacing the entire board of directors and then pushing for culinary changes, including selling more alcohol and better-tasting bread sticks at Olive Garden.

“Papa John’s has always stood for higher-quality pizza, and we believe Papa John’s has a strong foundation, with the best product in the space and a strong franchisee and customer base,” Smith said in announcing the deal.

“We see tremendous potential for the company both in the US and internationally,” Smith said.

Papa John’s has been suffering from stagnating sales amid fierce competition from other fast-food pizza chains.

The restaurant business is messy — but try telling that to Subway Restaurants, which is being accused of going after franchisees for minor infractions, like smudged glass, in an effort to put them out of business.

Mom-and-pop franchisees of the nation’s largest fast-food chain claim they’re under attack from an army of lawyers and store inspectors who are pressuring them to shutter or sell their stores, according to sources and court filings.

At the heart of the controversy is a 700-page-plus operations manual, which dictates everything from what oven temperatures to use to how to display vegetables.

“No one can comply with that,” Ohio lawyer Mark Shearer said of the manual. “[Celeb chef] Gordon Ramsay can’t comply with this.”

The Milford, Conn., company uses the manual to ding franchisees during monthly inspections for violations that can then put them in jeopardy of breaching their licensing agreements, according to sources and court filings.

In the case of Shearer’s client, Jack El Turk, who runs a Subway in Brook Park, Ohio, the company’s inspections led to complaints of “smudge marks on the glass in the dining room” and “coats and purses in the backroom,” according to court papers filed by Shearer.

In some cases, dinged stores are sold to Subway’s own development agents — the very same people who direct the monthly inspections, according to sources and court filings.

“My clients were targeted because sometimes they liked the store’s revenue and wanted the store for themselves,” Shearer told The Post, echoing his statements in a recent court filing about an Ohio franchisee who was allegedly forced out by a development agent “attempting to acquire restaurants in the territory.”

A Subway spokeswoman said the monthly inspections “are ensuring the high standards demanded by us and expected by guests are met.”

“If a restaurant is not meeting the requirements, the brand first makes every effort to work with the franchise owner to fix the issues,” she said.

But the accusations of an uneven playing field come at a time when the company known for the $5 footlong is flooding franchisees with legal actions.

The company took 955 actions against franchisees in 2017 and 718 last year. Most of the actions were through arbitration, which means the reasons behind them were not disclosed.

Based on the numbers alone, Subway is involved in hundreds more disputes with franchisees than McDonald’s, Dunkin’ donuts, Burger King, Pizza Hut and Wendy’s combined, according to restaurant consultant John Gordon of Pacific Management Consulting Group.

Subway initiated 702 arbitration actions against US franchisees in 2017, Gordon said, compared to one by McDonald’s, two by Dunkin’ and none by Pizza Hut, Burger King or Wendy’s.

“It stands out like a sore thumb,” Gordon said of Subway’s arbitration record.

Critics say the legal actions are tied to the company’s plan to slim down the chain amid sagging sales as competition for healthy and fresh food options grows.

Last year, Subway lost a net 1,108 stores, or 4.3% of total locations. McDonald’s, by contrast, lost a net 122 stores in 2018, or just 1% of its US base, according to regulatory filings.

San Diego restaurant chain is looking at securitization to change its capital structure

San Diego’s Jack in the Box said Wednesday that it has dropped efforts to find a buyer and instead will look to recapitalize the company through a debt securitization.

The move comes after Jack in the Box began exploring strategic alternatives last November, including a possible sale, under pressure from activist investors.

The fast-food restaurant chain also is facing a backlash from some franchisees, who contend it has failed to provide enough marketing and other support for their businesses. A group that represents owners of the bulk of Jack in the Box’s franchise restaurants has called for Chief Executive Leonard Comma to step down, among other things.

In a statement, the company said it contacted “a broad range of potential strategic and financial buyers, both domestic and international.”

At the same time, it looked at a range of financing options including a new capital structure that included adding debt through the securitization.

Jack in the Box’s board of directors opted for the latter. It expects to replace its existing term loan and revolving credit line with the securitization, which essentially means refinancing the loans with marketable debt securities that are sold to investors.

Once it pays off existing loans, Jack in the Box intends to use some of the proceeds for the debt securitization to repurchase shares, which could boost earnings per share and its stock price, depending on future financial performance.

“With this evaluation behind us, we are dedicated to moving the Jack in the Box brand forward,” said David Goebel, lead director of the company’s board, in a statement. “The Board of Directors unanimously and wholeheartedly supports Chairman and Chief Executive Lenny Comma and the entire management team as we collectively pursue a strategic plan focused on value creation as a standalone company.”

Just how much additional debt the company might take on through the securitization remains unclear. In a statement, Jack in the Box said it is targeting a leverage ratio of about 5 times adjusted EBITDA — or earnings before interest, taxes, depreciation and amortization.

“They’re saying we are going to do a securitization that is going to free up funds for general corporate purposes and for the share buyback and the like,” said John Gordon of Pacific Management Consulting Group, a restaurant industry adviser. “That may or may not be enough to get the activists out of their tailpipe. It really doesn’t do anything to alter the fundamentals of the business.”

At the end of its 2018 fiscal year, the company’s debt ratio was four times adjusted earnings of about $264 million, said Lance Tucker, chief financial officer, in a February conference call with analysts.

Jack in the Box has forecast adjusted earnings of $265 million for the 2019 fiscal year ending in September but aims to boost adjusted earnings to about $300 million in coming years, said Gordon.

“It looks like they are moving from approximately $1.1 billion in debt to $1.5 billion in debt,” with the securitization, he said.

Jack in the Box has been talking about securitization for some time. On the February conference call, Tucker said the move allows the company to tap into low interest rates. He added that the leverage ratio of 5 times adjusted EBITDA would be less than the ratio of some of the company’s restaurant industry peers.

Jack in the Box also reported fiscal second quarter earnings on Wednesday after markets closed. Revenue came in at $216 million, compared with $210 million for the same quarter last year.

Earnings from continuing operations were $25.1 million, or 96 cents per share, compared with $25 million, or 85 cents per share, a year earlier.

The company’s shares ended trading Wednesday up 44 cents at $77.84 on the Nasdaq exchange

John Schnatter sells $6M in Papa John’s shares

After stepping down from the Papa John’s International Inc. board in March following a settlement with the pizza chain, the company’s controversial founder and former CEO John Schnatter has sold 114,061 Papa John’s shares, worth approximately $6 million, or 1.1% of the total 9.9 million shares he owns, according to a May 10 SEC filing.

Schnatter still owns more than 30% of the company’s total shares.

The move comes just one week after Schnatter enlisted the help of financial advisors to help sell all or part of his 31% majority stake in the Louisville, Ky.-based pizza chain. Although the shares represent just a tiny fraction of the total stake Schnatter has in Papa John’s, he has indicated that this will not be the only shares he sheds.

“Based on his analysis of, among other things, investment considerations, economic conditions and public disclosures made by the Issuer, Mr. Schnatter may sell, trade or otherwise dispose of more or less of his Common Stock in the Issuer in the public markets,in privately negotiated transactions, in registered offerings or otherwise, consider and/or implement various alternatives to maximize the value of his investment in the Issuer, or take any other lawful action he deems to be in his best interest,” the original SEC filing stated. “Mr. Schnatter has solicited the advice of financial advisors regarding a possible disposition of all or some of his common stock in [Papa John’s].”

Schnatter originally stepped down as CEO in December 2017 following controversial comments during an earnings call in which he blamed NFL protests for Papa John’s struggles. Following last summer’s reports of racist language and behavior, he resigned as chairman. After more than a half a year of legal battles, Schnatter and Papa John’s have all but completely cut ties.

John Gordon, analyst at Pacific Management Consulting Group said the sale likely represents a small fraction of what Schnatter might try down the line:

“I believe the small stock sale by John is an attempt to test how much the market would react if he eventually dumps his shares,” Gordon said. “He has a duty not to harm the company … and his own share value. So, just a little check.”

Both Papa John’s and a representative for John Schnatter declined to comment on the sale.

Fuddruckers hasn’t exactly set the world on fire lately. Same-store sales in the burger chain’s fiscal second quarter declined 5.3%, parent company Luby’s Inc. reported this week.

And that was an improvement. Same-store sales in the first quarter declined by 11.2%.

Not surprisingly, the company is refranchising. Fuddruckers currently operates 54 company stores, following 14 closures over the past year and after the sale of five locations in San Antonio earlier this year. Franchisees operate another 102.

Refranchising has been a common strategy in the restaurant business for the past couple of decades, as executives embrace an investor-friendly and more profitable “asset light” business model.

But they’re really common when systems struggle, often coming across as a last-ditch rescue effort to keep chains afloat.

“They do it because they don’t have a better alternative,” said John Gordon, a restaurant consultant out of San Diego.

Famous Dave’s announced plans to refranchise its company stores in 2017, for instance. Those company stores had produced 13 straight quarterly same-store sales declines when it announced the plan.

Papa Murphy’s, which had employed a strategy of buying back struggling franchisees, after its 2014, began selling them back in 2017.

Steak ‘n Shake announced plans to refranchise all 415 of its company-owned restaurants last year, after its same-store sales turned south for the first time in nearly a decade. It has closed 31 locations this year to “prepare” those locations for incoming franchisees.

Refranchising isn’t necessarily a bad thing. Oftentimes, companies are simply bad at operating restaurants and better at franchising. And franchisees can do a better job of running the locations.

That was clearly the case when Burger King sold off all of its company restaurants to franchisees in 2012 and 2013. Many operators simply fixed up poorly operated restaurants and yielded improved profits.

Refranchising done right can inject some energy into restaurants while freeing up executives to concentrate on running the brand. The strategy can work, so long as the system focuses on ensuring franchisee profitability and operates the brand well.

When the brand is struggling, franchisees can frequently get stores at low prices because the franchisor is eager to let the restaurants go. The operators buying the units often pick off the best stores that can be more easily turned around, which can leave the franchisor closing weaker stores—Fuddruckers has been closing unprofitable stores for the past year, after all.

Still, such strategies can sap the credibility of the refranchising model when they’re done so frequently by companies desperate for a turnaround.

And just because franchisees are willing to take the risk of buying such stores doesn’t mean they are making a good decision.

Gordon pointed out that when an operator buys up a store that is losing money, it not only has to get that store to basic profitability, it has to generate enough profits to pay the royalty payment, which is typically about 5%.

And let’s not forget that many of these companies buying up stores are borrowing money to do so.

But the simple fact is that, if running stores were a more profitable venture, then more companies would seek to operate more stores.

And when restaurants are less profitable, companies seek to get out of it and hope someone else can do a better job. They often can, but sometimes they can’t.